Interest Rate Sledgehammer

I am currently in the middle of changing cities so I am going to make today’s post short and to the point.  Mark Carney is leaving the Bank of Canada for the Bank of England and so I think it is a good time to consider what challenges are facing Canada as he departs.

Household debt levels are too high, this is a common statement made by Mr. Carney, the government and whoever is being quoted in the daily business section of your favourite news outlet.  If we are talking about analysts and journalists then the suggestion is invariably for interest rates to rise.  Raise the interest rates to slow the borrowing of Canadians they say as if is was some fine tuned instrument that will target the housing market to deflate, but not pop, the bubble. Of course if rates go too high then people on variable rate mortgages will see their payments rise and some will default.  That would not be very good for the economy, but it would likely slow borrowing.  Higher interest rates would drive up our dollar as foreigners try to get in on the higher interest rates from countries where rates are still at rock bottom.  The higher dollar would make the all the neat things we import cheaper but it would make our exports more expensive at a time when Canada is trying to expand its trading horizons beyond the US.

However, as we have seen many times on this site the BoC keeps an eye on these things but its main concern is core inflation. The BoC philosophy is that the best way to keep the economy humming along is to maintain a core inflation level of 2%. Right now that inflation level is sitting at 1.3% — below target.  If we ignore the new thoughts we had about inflation for now and stick with traditional thinking the correct step at this point would be to lower interest rates.  Of course we know the BoC understands the delayed effects of anything it does and will likely not move the interest rates because their latest Monetary Policy Report (October) showed that they expect core inflation to return to a nice stable 2% near the end of 2013 or beginning of 2014.

So given the information that we have at the moment it appears that changes to regulation similar to the new mortgage rules are probably a better way to cool the housing markets because the BoC is not likely change its mind on the target overnight rate.

 

Please type what you think and why.